Your Credit in Purchasing a Home

If you haven’t applied for a mortgage loan in some time, don’t be surprised when you hear the words, "credit score," because those two words just may enhance your chance for being approved for financing.

Credit scoring, long used in the consumer lending and credit card arena, is now being used by the lending community in evaluating applicants for mortgage loans. The score indicates the borrower’s willingness to repay a consumer loan; it is based on the data available in the borrower’s credit report, and it measures the relative degree of risk a potential borrower represents to the lender. Items considered in credit scoring include past delinquencies, payment history, current level of indebtedness, length of credit history, and type of credit used.

Credit scoring is a useful tool when considered as only one part of the process, rather than as the main factor that determines whether a mortgage will be approved, denied or approved at a higher interest rate. Other factors that must be considered are the amount of collateral involved and the borrower’s ability to make the monthly payments. Credit scoring is useful in gauging risk to the lender, but those scores are not enough.

Credit scoring does not consider length of home ownership, length of employment, monthly income, ability to save, loan-to-value ratios, debt-to-income ratios or length of occupancy in current home. These items are generally included in mortgage scoring, a process that lenders use to determine the risk involved in issuing a mortgage.

Both mortgage scoring and credit scoring are achieved through automated underwriting, a process in which lenders electronically capture and evaluate data in a mortgage application. Automated underwriting has brought more consistency to the approval process. By applying uniform standards of creditworthiness, automated underwriting provides all borrowers the same objective treatment.

Automated underwriting and credit scoring may help change some industry perceptions that correlate level of income to credit history. Surveys by Fannie Mae have found that in many cases, buyers with low- to moderate-incomes frequently have much higher credit scores than those with high incomes. Moreover, those with a high credit score, but who can afford only a small down payment, are less likely to default than those with a low credit score who make a high down payment.

These developments in technology are expanding home ownership opportunities. By combining technology with information on credit risk and on loan-to-value ratios, we have increased the percentage of borrowers who are approved for mortgages. Automated underwriting can benefit consumers by expediting and streamlining the mortgage approval process, and by cutting costs.

The Federal Trade Commission (FTC) has a keen interest in credit scoring, because the commission is the agency with oversight for the Fair Credit Reporting Act and the Equal Credit Opportunity Act. The speed with which decisions are made through automated underwriting emphasizes the need for consumers to make sure their credit report is accurate.

It is vital that consumers check their credit report before they apply for mortgages.

Lenders are required to provide consumers with an explanation for mortgage application rejections. However, they are not required to provide consumers with an explanation for offering a mortgage at a higher interest rate. As a result, consumers should always ask lenders whether they are receiving the most favorable rate on the best terms.